The latest chapter in the ongoing UBIT saga involves a May 5 IRS technical advice memorandum released in early August that said taxes could be assessed on income earned from certain CUSOs, shared-branching arrangements and the sale of financial management services and certain insurance products.
Regarding CUSOs, the IRS is still not clear on if they would be required to pay UBIT, said CUNA General Counsel Eric Richard. The matter does not involve federal credit unions.
"The [IRS] analysis doesn't focus on the fact that it was a CUSO. There is a focus on members of the smaller credit union not being members of the big credit union," Richard said. "Some people are saying that it raises issues about income from CUSOs. It does raise some ambiguity."
In the memorandum, the IRS questions whether funds from a credit union, referred to as "T, a state-chartered credit union," generated through the following activities should be treated as UBIT under the tax code: the sale of MEMBERS Financial management services, sale of credit life and credit disability insurance, financial management services to a "smaller, newly created credit union," financial services to nonmembers through a shared branching network of credit unions, interest income, income received from the smaller credit union's provision of services to nonmembers and the sale of checks.
Some in the industry agree that much more clarity is needed on UBIT and CUSO activities. Michael Lozoff, chair of the financial institutions, credit union law group at Miami law firm Adorno and Yoss, said he agreed with Richards's point that the matter is ambiguous. He also concurred with the jury that ruled in favor of Community First Credit Union, which filed a UBIT suit against the IRS in January 2008. The IRS had argued that certain guaranteed auto protection and insurance products fell outside the credit union's mission. A jury disagreed and the Appleton, Wis.-based credit union was entitled to a $54,604 refund.
At the center of the recent IRS memo is T, which wholly owns X, a CUSO. The CUSO entered into a contract with a smaller credit union, referred to as "U" by the agency, to provide management services and assist in establishing appropriate policies and procedures. The CUSO also agreed to use its employees and T's employees to open accounts for members, accept deposits, process withdrawals, clear checks and process loan applications. The smaller credit union agreed to buy the data processing equipment while all funds were process through the CUSO's computer operations center. In addition to reimbursement for expenses, the CUSO was paid undisclosed amounts for the first and second years. After the first two years, the method of determining compensation was to be renegotiated under a separate agreement between T and the CUSO. T did file a UBIT Form 990-T for both years, the IRS said, but the amounts were not included as income derived from unrelated trade or business.
According to the IRS, T was not a party to the agreement between its CUSO and the smaller credit union.
"T has represented that the compensation arrangement it has with X is verbal and that it was unable to detail the terms of the verbal agreement," the IRS memo read. "T also stated that it performed all the services required under the contract on behalf of X to U. For years under audit T recorded [an undisclosed dollar amount] in management fees from U."
The IRS said T said its relationship with U and X "were not carefully delineated" and the associations "did not follow the pattern apparently contemplated by the written contract." The smaller credit union acted as a full service branch of T with signage reflecting both names. T stated that the revenues generated under the management contract were used to cover V's (only described as a "controlled entity") staffing and administrative support costs for operating the new branch facility. The smaller credit union subsequently merged into T. Meanwhile, the CUSO's Form 1120 filed for years under audit showed that its total assets were a certain dollar amount, which the IRS did not reveal in the TAM, and the return reflected zero receipts and expenditures.
The bottom line is to determine whether an income-producing activity is subject to UBIT, the IRS said it is necessary to show that there is a trade or business that is "regularly carried on" and its conduct is not substantially related to the organization's exempt purpose of function.
In the case of T, the credit union, it agreed that activities at issue were regularly carried on trades or business, the IRS said. Now the question is whether each activity is substantially related to the organization's achievement of its exempt purposes.
For CUNA, the matter is still murky at best. The trade's group CUNA's steering committee met on Aug. 7 to explore its next move, Richard said.
"It's going to be a long journey. We're continuing to work on the matter," he noted, adding the committee is talking to shared branching providers for more analysis. "First of all, the basic idea of [the IRS TAM] is very dubious."